The Wisdom and Madness of Crowds

Social scientists have always been fascinated by crowds. From guessing the weight of a cow to identifying which company built the faulty part in the space shuttle Challenger disaster, the many have often been able to outguess the expert few. Crowd wisdom is often cited as the justification for the idea of efficient asset markets -- many investors, each weighing in with their buying and selling decisions, should combine to produce the optimal forecast of what a stock or a bond is really worth. Or so the story goes.

But there’s danger in relying on crowds to make decisions. Under certain circumstances, group wisdom can break down and become madness. A classic example of this is when Reddit users tried to identify the Boston Marathon bomber, and ended up accusing the wrong guy. Many believe that asset-market bubbles are also examples of crowds gone mad.